How markets may react to what the Fed says

Stocks, bonds, the dollar and gold in view

SAN FRANCISCO (MarketWatch) — The Federal Open Market Committee meeting on Wednesday isn’t expected to yield any surprises. But as the markets learned with Federal Reserve Chairwoman Janet Yellen’s “six months” gaffe in mid-March, anything can happen.

Back then, U.S. equities sold off — and so did gold, as the dollar strengthened — in the wake of Yellen telling a reporter that the first rate hike could come as soon as “six months” after the central bank ended its bond-buying program. Many interpreted that remark, made as the two-day FOMC meeting ended on March 19, as putting the first rate rise as early as April 2015. Investors started to price in three rate hikes, instead of two.

For the FOMC meeting ending Wednesday, “there is little chance the Fed will announce any surprises,” said Keith Springer, president of Springer Financial Advisors in Sacramento, Calif.

“They have been very accommodating, both in their actions and their words. They will announce a continuation of their taper at $10 billion a month; that interest rates won’t rise until inflation picks up; and that they stand ready to act if the economy starts to slip,” he said. “Stocks will rally on this news.”

But Michael Gayed, co-portfolio manager of the ATAC Inflation
ATACX, +0.34%
and ATAC Beta Rotation
US:BROTX
Funds, wonders whether the Fed will “either taper less than $10 billion, or not taper at all, citing housing deceleration.”

Here’s how stocks, bonds, the dollar and gold may react under the various Fed decision scenarios:

Stocks

Between the selloffs of the momentum growth stocks and Ukraine tensions weighing on global markets, April is turning out to be generally flat for U.S. stocks. Two benchmark indexes — the Dow Jones Industrial Average
DJIA, -0.05%
and S&P 500 Index
SPX, +0.01%
— are each up 0.5% or less, month to date, as of Tuesday’s close.

Markets dropped earlier this month when momentum stocks fell out of favor and investors dumped them in droves. The selloff in high-flying names spread to broader markets.

Political turmoil in Ukraine and a threat of military action by Russia kept investors on the sidelines, as well. And while earnings results beat expectations at the usual rate of 63%, forecasts had been severely lowered.

As for the Fed, “the $10 billion tapering is already priced in. Markets are not expecting anything radically different from what the Fed has been saying so far,” said Paul Zemsky, chief investment officer of multi-asset strategies at ING U.S. Investment Management.

What would really throw the market off is “any change in language about tightening of the labor market slack, or anything that would indicate that the rake hikes would begin sooner than expected at the moment,” Zemsky added.

But Springer believes that if the Fed continues to taper as expected, “the jitters that the market has about interest rates rising before the economy has fully recovered will disappear — until the next Fed meeting at least — and there will be a rally in stocks across the board in response.”

Bonds

The bond market is on hyper-alert for new views from the Fed. If it gets the sense that a strengthening economy or a changed reaction function could bring forward the timing of rate hikes, intermediate-term Treasury yields may move higher. If rate rises seem to be more distant, those yields, which react most to shifts in monetary policy, could fall.

Bond-market participants aren’t expecting to get much new information, given that the Fed laid out a new outlook in March. But no one is ruling anything out.

“I think they would have to have some very strong view on the economic outlook going forward, or some input on forward guidance that rates would be raised sooner or later,” said Tom Tucci, managing director and head of Treasury trading at CIBC World Markets Corp.

Treasury yields have been largely range-bound in recent months, as investors wait for new information about the pace of economic growth. The 10-year Treasury note
US:10_YEAR
yield has largely traded between 2.60% and 2.80%, having closed out Tuesday at 2.7%, according to Tradeweb. The benchmark yield is on pace to close out April 2 basis points lower, according to FactSet.

The dollar

Action in the U.S. dollar
DXY, +0.38%
could come from changes in Fed officials’ language. “The one thing they can do that would be dollar-positive is if they sound more positive about the economy,” said David Woo, head of global rates and currency research at Bank of America Merrill Lynch.

More specifically, references to the fading weather effects and increased confidence on the growth outlook could boost U.S. rates and pull the dollar higher against the yen, he said. A push above ¥102.62 in the dollar-yen
USDJPY, +0.03%
pair could set up for a run on the ¥103 level, he added.

On the other hand, any comments about housing market could weigh on the dollar.

“The Fed is very much in data-dependency mode,” said Woo, adding that there’s a slim chance of a surprise from its statement. The dollar has lost nearly 0.7% against the yen this month, in line with a decline in the yield of the 10-year Treasury note, as investors have assessed economic data for its implications on U.S. monetary policy.

Gold

Lately, the tensions between Russia and Ukraine have provided a safe-haven boost to gold
US:GCM4
with futures prices set for a gain of around 1% for April.

Expectations that the Fed would soon begin tapering its bond-buying program contributed to the precious metal’s 28% price plunge last year. The taper officially began in January, and prices have since rebounded to trade nearly 8% higher year to date.

If the Fed announces a continuation of the QE taper at the current pace, and it confirms its guidance following the last FOMC meeting, then “the result will be neutral for gold,” said Brien Lundin, editor of Gold Newsletter. “However, as we saw with Yellen’s press conference after the last meeting, the markets could swing widely on the barest nuances.”

But if the Fed “tapers the taper,” gold will “take off like a rocket,” Lundin added. “On the other hand, any scenario involving a quickening of the taper or rate hikes sooner than expected would send gold diving.”

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